The Bankruptcy Code was established to allow insolvent borrowers - including individuals, companies, and municipalities – to undergo a court-supervised path for restructuring debts, so that our economy can continue to promote the most efficient use of resources. Unfortunately, there is one exception.
Despite its own insurmountable indebtedness, Puerto Rico does not have the same option that every other American municipality has. Congress should pass the Puerto Rico Chapter 9 Uniformity Act (H.R. 870) to change this.
Bankruptcy is Puerto Rico’s last hope. Despite my public affirmations that bankruptcy has been inevitable for some time, I didn’t come to this affirmation easily. Something just doesn’t seem right about allowing a poorly-managed government to rid itself of its obligations. But Puerto Rico has been inching towards insolvency for years, and recently speculators are the only ones betting that it won’t find some way to restructure.
What led to its current fiscal distress? To put it simply, Puerto Rico has a historical addiction to spending that would make our nation’s most indebted states uncomfortable. Investors desperate for returns higher than what Treasury bonds - and most municipal bonds - can offer, have been the island’s enablers, unwilling to confront what everyone has seen as a growing problem.
Will D.C. be able to deny assistance, knowing that Puerto Rico lacks any other way out? Ask President Obama, who has appointed a special team to consider Puerto Rico’s options.
Most now know that Puerto Rico must do something drastically different, and soon, but the unfortunate side effect to kicking this can down the road has been a precipitous decline in the number of businesses willing to trust that they won’t be forced to pay the tab.
Economists recognized Puerto Rico’s unsustainable debts years ago, but there were glimmers of hope and lofty speeches that distracted us along the way. However, the one indicator that has consistently predicted government default elsewhere (including in many Latin American countries), is now pointing to the same inevitability in Puerto Rico: Puerto Rico’s long-term growth rate is far lower than the rate at which it can borrow, making its debts insurmountable.
In fact, the island’s economy has been stagnating or shrinking for nearly a decade, while its cost to borrow has continuously increased. Some analysts expect the next round of requisite financing, backed by revenues from a new tax on oil, to come in at around nine percent. This is infinitely greater than the flat growth I expect in the near future, and still more than 40 times higher than the Puerto Rican government’s anticipated 0.2 percent growth for 2015.
Any additional austerity measures (which generally equates to more taxes and cuts in spending) required for new borrowing will suppress economic activity even more, making it impossible for Puerto Rico to overcome this obstacle.
The solution of last resort is now obvious, but - for reasons that no one seems to understand - our elected representatives in Washington excluded Puerto Rico from the same recourse that every other municipality (and nearly every borrower, for that matter) in the country has available to it.
Consider that this legislative oversight may have been part of the reason for the depth of its financial hole in the first place. Lenders have known about Puerto Rico’s inability to file for bankruptcy, meaning that speculators haven’t had to fear the wrath of mismanagement. Now that it’s time to negotiate, these lenders have all the leverage.
In addition to hedge funds, millions of Americans also have exposure to Puerto Rico’s bonds, but for the most part these investments are a small fraction of diversified portfolios. Given that markets are already pricing in the possibility of a restructure, mom-and-pop investors can expect very little additional per capita loss if bankruptcy is permitted.
Some think that a municipal bankruptcy will force the Federal Government’s helping hand, but recent history proves otherwise. After the Great Recession, a number of municipalities were forced to go through court-monitored restructures when Uncles Sam’s tolerance for bailouts had reached its limits. American taxpayers didn’t have to pay anything.
On the other hand, if Puerto Rico doesn’t have the option to restructure its debts, it will eventually have no choice but to put its hand out to Washington. Will D.C. be able to deny assistance, knowing that Puerto Rico lacks any other way out? Ask President Obama, who has appointed a special team to consider Puerto Rico’s options.
There’s a reason we’ve set up the bankruptcy option, and it’s not just so we can slip out from under our obligations without any repercussions. As a society, we’ve found that it’s the most efficient way of ensuring an organized restructure that doesn’t create market chaos, and, in the case of Puerto Rico, unnecessarily harsh economic repercussions for millions of Americans.
Even if H.R. 870 is passed, and Puerto Rico decides to take itself to bankruptcy court, it is going to be a long, hard road to regain economic growth. And it will be an even tougher one with a new market of skeptical lenders, far less likely to take the risks they historically have.
Nevertheless, there are now no good options for Puerto Rico, only less bad ones. The least bad path for Puerto Rico, and the rest of the country, is to allow it to undergo a supervised restructure, instead of the more chaotic, but still inevitable, extrajudicial one.